The software maker plans to start giving employees grants of stock rather than options to buy shares as part of a shift in the way it compensates its employees.
"There will be no new stock options grants from Microsoft," company CEO Steve Ballmer said during a conference call. "Instead, we will award actual stock. The stock will vest over time, just like our stock options vested over time--a five-year (period) in our case."
Ballmer said the company spent the last year trying to come up with a system that reduced employees' anxiety over compensation while still being "at least as good" for the shareholders.
In a statement, Microsoft said the change will go into effect in September. Separately, the company said it is in talks with J.P. Morgan on a deal that would allow Microsoft workers to sell existing options that are "underwater," meaning the price at which they can be exercised is greater than Microsoft's current share price. That program is still under development and is subject to regulatory review, but Microsoft said if it is approved, it should take place by the end of the year.
As a result of the changes, Microsoft will begin expensing all stock-based compensation, including previously granted stock options, starting in fiscal 2004. "Because stock awards must be expensed as they vest, we will include the cost of all equity-based compensation in both future and prior years' financial statements to preserve year-over-year comparability," John Connors, Microsoft's chief financial officer, said in a statement.
The moves come amid growing controversy over how to account for the cost of awarding stock options, with regulators and investors seeking to have companies count option grants as an expense.
Other technology companies, notably Intel, have railed against requirements that would force companies to account for stock options as an expense. Hewlett-Packard and IBM shareholders narrowly voted down proposals that called for the companies to expense stock options, while Apple Computer shareholders approved such a measure despite management's objections.
An Intel representative stated that the company has no plans to switch from granting stock options. Earlier this year, Intel had Jane Shaw, head of its board member and compensation committee, review a variety of alternatives to granting options, including giving employees restricted stock. The company chose not to change how Intel provides equity compensation.
It is not unusual for companies to give restricted stock grants to some executives, although it has not been the norm thus far for companies to replace stock options with restricted stock for rank-and-file workers. Restricted stock programs are popular overseas in places like Taiwan, where options are less common.
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Microsoft's change in compensation policies also comes amid questions about the company's plans for its massive cash holdings, with some calling on Microsoft to return some of its money to shareholders either through increased dividends or a lump-sum payout.
"Our compensation philosophy is simple," Ballmer said. "We want to be a magnet for the best people by paying smarter. We want to attract and retain employees by offering real ownership and great long-term financial incentives. And we want to ensure that our senior employees' total compensation is even more closely linked to growth in the number and satisfaction of our customers."
The company said "a significant portion of stock-based compensation for more than 600 of Microsoft's senior leaders will depend on growth in the number and satisfaction of Microsoft customers." Ballmer and Microsoft Chairman Bill Gates will not receive stock awards, the company said, adding that the pair have never received stock options.
In terms of assessing the effect of the plan on employees, Ballmer said, that at current stock prices, workers benefit more under the new plan. When Microsoft is at higher stock prices, however, workers would benefit more by getting options. Ballmer added that the change should boost the number of employees who actually hold Microsoft stock, as opposed to those who exercise options.
"It's always good to have the employee base thinking just like the shareholders where that's possible," he said.In a statement, Cisco Systems Chief Executive John Chambers said that Microsoft's shift had not altered its own thinking on employee stock options.
"Our views have not changed," Chambers said in a statement. "Broad-based employee stock option plans are vital to the growth, innovation, and the future of the technology industry and jobs in this country."
CNET News.com's Michael Kanellos and the Reuters news agency contributed to this report.